Money is flowing into passively managed bond funds

“Active bond fund managers have been able to increase their returns [over indexes], by adding credit risk to their portfolios, especially over the last five years,” said Alex Bryan, director of passive strategies research at research firm Morningstar. “Anytime volatility picks up, you’ll see more flows into Treasurys, and active managers taking on more risk will look worse than their index peers.”

Since the financial crisis, assets have been migrating en masse from higher-cost actively managed funds to lower-cost passive funds that track an index. In the stock market, the numbers are staggering. If the trend continues, passively managed equity fund assets could top active within a couple of years.

It’s happening in the fixed-income markets, too, but at a slower rate. Over the past five years, $629 billion in assets have flowed into passively managed bond funds and $206 billion has flowed into active funds. Yes, that’s slower than the trend in stocks.

“We like the lower cost of Vanguard bond funds,” said Barry Glassman, a certified financial planner and president of Glassman Wealth Services. “It’s hard to justify paying higher fees when yields are so low.”

While low-cost bond funds that track an index have become more popular, actively managed funds are still attracting plenty of cash from investors. Last year, the taxable bond category experienced the biggest inflows of any category tracked by Morningstar. Indexed mutual funds and ETFs attracted $210 billion and actively managed funds pulled in $179 billion.

In smaller, less liquid segments of the bond markets, however, there is a wider dispersion of returns on individual securities and active management is perceived as adding greater value than in the Treasury and investment grade bond markets.

“There’s a perception that there is a higher return to fundamental research in the high yield market,” said Bryan. “Active management is much bigger in high yield.” At the end of April, actively managed junk bond funds held $247.5 billion in assets versus $41.6 billion in index funds.